Economic forecasting is famously unreliable. While this problem has traditionally been blamed on theories such as the efficient market hypothesis or even the butterfly effect, an alternative explanation is the role of money – something which is typically downplayed or excluded altogether from economic models. Instead, models tend to treat the economy as a kind of barter system in which money’s only role is as an inert medium of exchange. Prices are assumed to almost perfectly reflect the ‘intrinsic value’ of an asset. This paper argues, however, that money is better seen as an inherently dualistic phenomenon, which merges precise number with the fuzzy concept of value. Prices are not the optimal result of a mechanical, Newtonian process, but are an emergent property of the money system. And just as quantum physics has its uncertainty principle, so the economy is an uncertain process which can only be approximated by mathematical models. Acknowledging the dynamic and paradoxical qualities of money changes our ontological framework for economic modelling, and for making decisions under uncertainty. Applications to areas of risk analysis and economic forecasting are discussed, and it is proposed that a greater appreciation of the fundamental causes of uncertainty will help to make the economy a less uncertain place.

July 19, 2015

The answer to the question “what is money?” has changed throughout history. During the gold standard era, money was seen as gold or silver (the theory known as bullionism). In the early 20th century, the alternative theory known as chartalism proposed that money was a token chosen by the state for payment of taxes. Today, many economists take an agnostic line, and argue that money is best defined in terms of its function, e.g. as a neutral medium of exchange. This paper argues that none of these approaches adequately describe the nature of money, and proposes a new theory, inspired by non-Newtonian physics, which takes into account the dualistic real/virtual properties and complex nature of money. The theory is applied to the example of the emergence of cybercurrencies.

July 11, 2015

Readers of this column, no doubt concerned for my wellbeing, have occasionally asked how my book Economyths – a critique of mainstream economics from the point of view of an applied mathematician – was received by economists.

The book, which also served as the basis for many Econoclast articles, did muster a number of positive reviews, from publications ranging from Bloomberg to Handelsblatt. The science writer Brian Clegg called it “probably one of the most important books I’ve ever read” (he’s not an economist, I just wanted to mention it, before we go on). Perhaps the strongest endorsement was from Czech economist Tomas Sedlacek, who co-wrote a subsequent book with me.

May 8, 2015

It is often said that quantum physics is so weird that it is beyond our understanding. But there is one area where some quantum insights might prove applicable to our everyday lives, and it’s a surprisingly common one: money. Just as subatomic objects have a dual nature, so do the money objects that we use to make payments. The main difference is that these objects are things we have designed ourselves. They are our contribution to the quantum universe.

April 5, 2015

According to the authors Lipsey and Ragan of Canadian textbook Economics, money emerged as a replacement for barter: “If there were no money, goods would have to be exchanged by barter… The major difficulty with barter is that each transaction requires a double coincidence of wants… The use of money as a medium of exchange solves this problem.”

Fortunately the book was free, so in this case neither barter nor money were required. The authors went on: “All sorts of commodities have been used as money at one time or another, but gold and silver proved to have great advantages… The invention of coinage eliminated the need to weigh the metal at each transaction, but it created an important role for an authority, usually a monarch, who made the coins and affixed his or her seal, guaranteeing the amount of precious metal that the coin contained.”

This seemed clear enough. Commodity money emerged from barter. The best commodities, for various reasons, were gold and silver. The only role of government was to come along at the end and put its stamp on the coins. I had seen the same argument made before, with minor variations, by 19th-century economists such as William Stanley Jevons and Carl Menger, and by Adam Smith in the 18th century. But to check it out, I decided to go right to the source, the origin of origin stories: the philosopher himself.

December 15, 2014

“Prediction,” the great physicist Niels Bohr is said to have once observed, “is very difficult. Especially when it concerns the future.” In science and economics, our lack of ability to foresee the future has traditionally been attributed to two theories – the butterfly effect, and the efficient market hypothesis – which have more in common than might appear.

The “butterfly effect” was first coined by the meteorologist Ed Lorenz in a 1972 talk, based on an earlier paper in which he observed that the solutions to a highly simplified weather model were sensitive to initial conditions. When he slightly changed the inputs to the model and ran the simulation, the answer changed completely. This was like running a weather prediction model using slightly different values for today’s weather, and getting wildly divergent forecasts for the weather next week.

June 24, 2014

In 1955, Daniel Kahneman was a psychologist in the Israeli army, charged with finding out which soldiers would make good officer material. He devised a simple test: divide the men into groups of eight, remove their insignia to hide rank, and tell them to lift a telephone pole over a six-foot wall. This would reveal who were the leaders, who were the followers, and who were the quitters (or thought lifting ridiculously heavy telephone poles over a wall was a waste of time). After each batch, Kahneman and his team would recommend those soldiers they thought had the right stuff for officer school.

Every now and then, Kahneman would get feedback from the school on how his recruits were doing. The news wasn’t all good. It seemed being talented at pole-lifting didn’t translate directly into being good officer material. In fact, according to Kahneman, “there was absolutely no relationship between what we saw and what people saw who examined them for six months in officer training school”.

Interestingly, this piece of information did not change Kahneman’s mind about the validity of his technique. “The next day after getting those statistics, we put them there in front of the wall, gave them a telephone pole, and we were just as convinced as ever that we knew what kind of officer they were going to be.”

Kahneman thought he was testing the soldiers – but he turned out to be testing himself. He was clinging to his theories, even when they were in conflict with data. He later coined a name for the phenomenon: “the illusion of validity.” We put too much faith in our power of judgement, and tend to ignore or downplay information that doesn’t agree.

Although it came too late to save the army careers of a number of soldiers, the insight would eventually lead to the creation of a new field of study – behavioural economics – that is now influencing behaviour at the highest level of governments, and reshaping our understanding of economics.